No Justification for Rescuing Banks

If my local grocery store loses too much money because hard-pressed shoppers are going to the supermarket down the road, which charges less, there is no talk about saving it. The store is allowed to fail.

So if a bank loses too much money, why does it have to be rescued? Why not let it fail too?

There is much talk about the need to support banks because of their vital role in providing money to households and small businesses. But if the last few years have taught us anything, it’s that many households are now in trouble because they borrowed too much. And small-business owners are lining up to tell us that the banks aren’t lending them money now anyway.

So we move on to the arguments about systemic risk, and “too big to fail”. But if my corner shop closes, that helps its competitors; it doesn’t hit them. Even if one of the major supermarket groups failed, the others would gratefully welcome its customers.

What’s more, it’s not clear that governments can rescue their banks without suffering severe strains themselves. Just look at Ireland, where rescuing them brought the state close to insolvency.

France seems to have realized that if it had to guarantee the assets of its troubled lenders, like the French-Belgian bank Dexia, its triple-A rating would be at risk. However, German chancellor Angela Merkel said this week that recapitalizing some banks can be justified, and Antonio Borges, director of the International Monetary Fund’s European department, said all large regional banks should be recapitalized to boost market confidence, with the recapitalization coming from governments if not the private sector.

Fortunately, this writer is not alone in seeing this as the economics of the madhouse. Here’s what the commentator Dennis Gartman says:

“What we have in Europe is the very ironic position that the banks are asking to be bailed out by the sovereigns for having bought the sovereign’s debts. Here in the U.S., the banks previously had to be bailed out by the sovereign for having bought the debts of the public via real-estate loans gone awry, but in Europe it is somewhat different. The banks… whether French, or German, or Greek or Irish or whatever nationality… loaded up their balance sheets with the sovereign debts of one another and now the sovereigns are being asked to come to the bank’s aid. If it were not so sad this would almost be comical. But the point is, it is so sad and it is not comical in the least.”

Precisely. Not comical. So perhaps someone could explain just why this latest bank-rescue planning makes sense.

Comments (3 of 3)

Comparing banks to a corner shop is an over-simplification, or just wishful thinking!

If only banks were like corner-shops i.e. practically standalone, but they are instead intricately and complicatedly interlinked with each other and the underlying economic system. Bank failures will have a cascading and catastrophic effect on the world economy.

This is not to say that I support "rescuing" the banks but things have to be put in perspective. The economy needs help and one means to offer that is via "helping" banks out. It is a whole new discussion whether the banks are indeed being "bailed" out. If you ask banks, they would not think so. With extra capital requirements and buffers, smothering regulatory layers and weakened demand for their products, they are actually fairly stressed out right now.

The challenge for politicians and central banks is to strike a balance between free bailouts (much of this is perception..the government bailouts have been very expensive for banks) and crippling regulations. This is a hard one and always subject to games played by politicians to enrich their vote banks. Politicians would like for people to believe that banks are the cause of all their misery as that lets them off the hook for not having seen the trouble brew up nor having instituted good oversight of the banking system in the first place.

It is for us, the people to peel the layers of the onion before forming an opinion.

1:08 pm October 6, 2011

game theory wrote:

In the US, the heart has almost failed...it grew too large...now the patient needs a transplant...and the patient will end up with a mechanical heart via nationalization. In Europe...the heart will just stop completely and the EU will splinter. Even if the politicians agree, the value systems of the various peoples involved is far too different for there to be unity.

12:37 pm October 6, 2011

Matt Zobian wrote:

There is absolutely no problem with a single bank failing. The problem is with MANY banks failing: the economic impact is huge since the bank system is the organ that pumps capital through the economy.

And yes, the situation you cite is absurd. But that isn't precisely the situation in Europe. The banks are not going to be re-capitalized by Greece, Portugal, Ireland and Italy. They're going to be re-capitalized by an EU consortium backed by Germany, France, and The Netherlands. The fiscal firepower is there, the question is: where is the political will and solidarity?

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